Schumpeter Theory of Business Cycle

Prepared by: Manish Dash

Business Cycle
The business cycle represents wavelike fluctuations in the level of business activity from the equilibrium or trend line. Schumpeter

Innovation theory
Joseph Schumpeter has explained the expansion and contraction in business cycle through industrial innovation. Whenever innovation takes place, it causes disequilibrium in the economy Continues till re-adjustment at some new equilibrium level. The innovation is the introduction of a new product in a full employment economy

What is innovation?
Schumpeter argued that innovation comes about through new combinations made by an entrepreneur, resulting in
The introduction of new goods, that is the one with which consumers are not familiar, of a new quality. The introduction of new method of production The opening of new market The conquest of new source of supply of raw material The carrying out of new organization

Features
Distinction between invention and innovation
Schumpeter makes a distinction between innovation & invention. Invention means creation of new things and innovation means application of new things on to practical use

Emphasis on entrepreneurial function

Schumpeter has given emphasis on the role of entrepreneurial functions in economic development. In his views, development means basic transformation of the economy that is brought about by entrepreneurial functions

Contd
Presentation of disequilibrium situation through entrepreneurial activity
The entrepreneurial activity represents a disequilibrium situation, a dynamic phenomenon and a break from the routine or circular flow or tendency towards equilibrium

Entrepreneurialism dream and the will to found a private kingdom

The motives of creating things and applying these things into practice inspire the entrepreneur to undertake innovation.

Schumpeter not only foresaw the importance of the individual and of technological innovation in advancing an economy, he also recognized that in advanced capitalist economies, once a wave is over, entrepreneurship will cease to exist and will come to be replaced by socialism.

According to Schumpeter's model, we can expect depression, more socialism, and a flattening of society to continue for at least another 10 years, into the beginning of a Sixth Schumpeter Wave around 2020.

Critical Evaluation
Schumpeters Theory of Innovation is criticized on the following grounds :
The theory has the scope of entrepreneurism in the sense that it has included the individual businessman along the directors and manager of the company Schumpeter innovating entrepreneurs represents the enterprise with the R & D and innovative character. But developing countries lack these character.

Contd.
The theory emphasizes on innovation and excludes the risk taking and organizing aspects Schumpeters entrepreneurs are large scale businessman who introduce new technology, method of production. Schumpeter remained silent about as to why some economics had more entrepreneurial talent than others.

However, despite the above criticisms, Schumpeters theory of innovation is regarded as one of the best business cycle theories.

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